Can Environmental Regulation Enhance Firm Performance? Evidence from a Natural Experiment

Exploiting the Central Environmental Inspections (CEI) in China as a quasi-natural experiment, we find that public firms in polluting industries experience significant gain in both profitability and market valuation after the regulatory shock, relative to firms in nonpolluting industries. The outperformance of public firms can be explained by the retreat of their private competitors, many shut down due to poor environmental performance. Because firms seeking public listing are required to meet high environmental standards, CEI significantly strengthen public firms’ competitive position, leading to increased sales growth and market share. Moreover, the outperformance is more pronounced for firms with more eco-friendly technologies, consistent with strict environmental regulations increasing the marginal benefit of environmental technologies. We provide novel evidence of the bright side of environmental regulation by highlighting the importance of industry dynamics